The following article is an except form pages 93-102 of my book The Conscience of a Young Conservative. If you enjoy, free PDF copies are available through Liberty.me, and print copies are available on Amazon. 

Put briefly, American health care is so expensive because our system infuses capitalism with the worst of government intervention.

Third Parties

“Third parties” in health care are any outside force that prevents the consumer from feeling the full financial cost of the services he receives. Health insurance is the third party that most people use, while Medicare and Medicaid are third parties that the elderly and poor utilize. In the real world, everyone price shops, but is far less likely to do so when someone else is paying the bill. John Stossel gives the analogy of what a world with grocery insurance would be like:

With your employer paying 80 percent of the bill, you would fill the cart with lobster and filet mignon. Everything would cost more because supermarkets would stop running sales. Why should they, when their customers barely care about the price?[1]

This isn’t a perfect example, because in the case of healthcare, insurance and government is paying far more than just 80 percent of the bill! But either way, if we barely pay the price, why care if the price rises? Most people do not: one survey even showed that only 12 percent of people do any research on costs or quality of certain health care providers each year.[2]

Separating consumers from the cost allows hospitals to charge hefty markups on their services. The website “Hospital Bill Review” suggests that anywhere “from 157 percent to 702 percent markup for procedures is commonplace.”[3] To put this in perspective, the markups on hotel mini-bars go up to 400 percent, fountain soda between 300-600 percent, and around 300 percent for lattes.[4]

In his 2001 essay How to Cure Health Care, Milton Friedman attributed 60 percent of the increase in health care costs from 1946-1997 to tax exempt health benefits, Medicare, and Medicaid.[5] Friedman also calculates that if health care spending rose at the same pace it did from 1919 to 1940, which was 3.1 percent per year, per-capita health care spending would have been $1,751 in 1997 instead of $3,625.[6] These figures are inflation adjusted in dollars for the year 2002.

FDA Regulation

Along with the passage of the Kefauver Harris Amendment (also known as the Drug Efficacy Amendment) in 1962, the Food and Drug Administration increased its strength in the regulation of drug production. As of 1938, drugs had to pass a “proof of safety requirement,” but the 1962 law added both a “proof of efficacy” requirement and removed time constraints the FDA had to respond to applications for new drugs pharmaceutical companies wished to have enter the market.[7]

Like most government agencies, there are good intentions behind the FDA’s approval of drugs. By some estimates, their preventative policy saves 10,000 lives per decade. Putting together such an estimate is easy, but what is not easy is calculating the amount of lives lost due to the length of the FDA’s drug approval process. In the 1990’s, it took slightly over 15 years for a new drug to get through the FDA’s approval process. Even if the drug ended up saving only 1,000 lives a year, the FDA’s regulations saved a net zero lives that decade. The problem is that there is not one, but thousands of potentially lifesaving drugs delayed from entering the market. An additional side effect is that it deters drugs from entering the market in the first place.

As Milton Friedman and his wife documented in their 1980 book Free to Choose, from the onset of new regulation in 1962, the amount of “new chemical entries” into the market had declined by over 50 percent each year until the publication of their book. Another group that excessive regulation harms is patients with rare diseases, as pharmaceutical companies wouldn’t be able to recoup costs in producing drugs to treat such a small segment of the population.[8]

Even when they are not preventing drugs from entering the market, the FDA prevents lifesaving information from doing the same. From 1974 to 1980, plenty of studies were published demonstrating that aspirin reduces the risk of both death and repeat heart attacks by 20 percent for heart attack victims. The FDA wouldn’t allow aspirin makers to disclose this information to doctors until 1988. Another study showing that aspirin reduces the risk of death for heart attack patients with unstable angina (when the heart doesn’t receive enough oxygen) by an astonishing 50 percent also was also banned until 1988. Another study from the same timeframe showed that when taken daily for the month after a heart attack, aspirin reduces odds of death by 23 percent. This information was hidden from the public until 1996. On the international scene, the European Union has banned the claim that water can prevent dehydration after conducting a three-year investigation into this claim![9]

As stated earlier in this chapter, the costs to produce a new drug averages around $1.3 billion. Milton Friedman commented on the role of the FDA in increasing this cost as well, noting that before new regulation in the 1950s and early 60’s, it cost half a million dollars and 25 months to bring a new drug to the market. By 1978, it had cost $54 million and eight years to bring a new drug to the market. Clearly this trend had has no signs of slowing down.

The $1.3 billion cost from FDA regulation then translates into higher costs for the consumers of those drugs. Not only does the producer have to recoup over a billion dollars, their timeframe to do so is limited. The patent on a new drug lasts between seventeen and twenty years, so when it expires another company can easily produce a generic and sell it for a lower price. One hundred tablets of Xanax cost $0.024 to produce, and sell for $136.79. This is effectively a markup of 570,000%.[10] Xanax has the highest markup of any prescription drug I could find, but other drugs still have absurd margins. Prozac’s markup is 225,000%, Norvasex’s 134,500%, and the lowest I could find was Zestril, at 2,800%.[11]

Perhaps reducing the length of a patent could solve the problem of high markups? Reducing the length of a patent may sound good in theory, but all shortening monopoly status for a few years would accomplish is for the cost of drugs to be even higher for a slightly shorter amount of time, since firms would still need to recoup costs from their investment. Reducing patent times too drastically would stifle innovation of drugs that producers consider to be a risky investment. The best way to reduce costs with the least amount of unintended consequences would be to lower production costs for firms looking to enter the market so they could enjoy the same amount of profits while charging a lower price.

Price controls may have made certain drugs in other countries cheaper than they are in the US, but our generics are cheaper, as would be expected through competition. The profit incentives are completely reversed: in America drug producers have to make money by charging more for drugs since they have a small timeframe to do so, while drug companies under the socialized system have to make a profit by charging more for generic drugs not limited by price controls.[12]

Relieving the stranglehold the FDA has on pharmaceutical companies would decrease the costs of drugs and help maximize the number of lives they can save. This kind of reform could also encourage self-regulation inside the industry due to the threat of lawsuits that would arise from a harmful drug.

Mandates Within Insurance

Different types of mandates have been discussed in this chapter, thus far with a focus on mandated purchase of insurance. However, there are other forms of health care mandates. One form of mandate is one wherein the health insurance company itself forces people to purchase coverage for health procedures they are unlikely to ever need. Although the purpose of insurance is to contribute to a risk pool and thereby spread the risk, for many of these procedures it is questionable as to whether insurance should even cover them.

Mandates for coverage of specific procedures have been on the rise. While only seven healthcare mandates existed in 1965,[13] there were 2,156 in 2010.[14] These mandates are found throughout the states, Idaho having the least amount of mandates (13), and Rhode Island having the most (69).

Forcing people to join any kind of risk pool comes at a cost. Forty five states mandate benefits for alcoholism, 48 states have a mandate for breast reconstruction, 40 states have mandates for general mental health issues, while 42 states have mandates for mental health-parity and 30 states mandate contraceptive coverage.[15] This adds up; the alcoholism mandate adds 1-3% in added costs, general mental health adds 1-3% in costs, mental health parity adds 5-10% in costs, and contraceptives add around 1-3% in costs.[16] Of course, if every mandate added such a large amount in costs, no one would be able to purchase health insurance, and luckily most mandates increase costs by less than 1%. However, even a small cost increase of 1% translates into a lack of affordability for some people – between 22,222 and 33,333 according to one estimate.[17]

The states that add the most mandates show the largest increases in their uninsured population. Even as early as the 1990’s, when hundreds less mandates existed, this trend held true. The Heritage Foundation tracked the progress of the 16 states which attempted to implement the policies of the failed Clinton healthcare reform plan and in doing so passed the most aggressive mandates between 1990 and 1994. The results weren’t pretty. In 1996, the 16 most regulated states saw their average uninsured population increase by 8.14%, while the other 34 states showed a drop in their uninsured population of 1.02%.[18]

Insurance Regulation

If private insurance companies could truly compete with one another, premium prices would decline dramatically. Imagine two towns next to each other, each containing multiple pizza stores. If the average price of a slice cost $2 in one of the towns and $10 in the other, it is obvious that everyone would purchase pizza from a store in the cheaper town. If it were made illegal to cross towns to purchase pizza, however, the town charging $10 would never have to change their price, and could even increase it if they wanted too. A similar scenario occurs among private insurance companies, but on the national level, and with much larger amounts of money involved.

Regulation of health insurance is felt by consumers in the form of increased premiums. Highly regulated states like New Jersey have premiums seven times higher than in Tennessee. States like Wisconsin have average family premiums of $3,000, while in Massachusetts the average cost is $17,000.[19] Yet people cannot buy health insurance across state lines.

If competition was allowed, it would be impossible for companies to charge as much in premiums – assuming they want to stay in business. Why pay $17,000 when you can pay $3000 instead? Of course, it would only be possible for states like New Jersey and Massachusetts to begin to compete if their state-level regulations were eased. Some of these regulations force the insured to insure themselves against certain things they don’t necessarily need – which would be akin to wanting to purchase insurance on a house but being forced to also purchase insurance on your non-home property as well, which would increase your premium above what it would have been had you only bought home insurance.

In addition to anti-competitive measures at the state level, other insurance regulations limit the gap between what different age groups can be charged for care. This may seem like good policy; in this way, older and less healthy individuals aren’t charged too high a premium. But for this to work, costs are then pushed back on younger holders of insurance. Since these younger individuals are much less likely to have health problems, they can drop their health insurance policy without much worry.

The way insurance companies balance costs and turn a profit is through the process of cost averaging. In the US, the oldest users of private health insurance (under 65, when Medicare begins to be used), spent six times more on health care than the youngest users of health care. Community ratings are put in place to prevent the oldest from paying six times as much. ObamaCare uses a 3:1 community rating, simply meaning that the oldest users can’t be charged premiums three times higher than the youngest users. This lowers the cost for older users, but only at the expense of younger users. As a result, many of the younger insured drop their coverage since they hardly use any medical care anyway, but this withdrawal from the insurance pool then increases the premiums of everyone else who remains in.[20]

Recently, one state acted against the general trend towards more regulation and as expected saw overall health insurance costs decline . Maine’s deregulation focused only on reducing the gap between what different age groups could be charge. The gap in pricing of premiums could only be 1.5 to 1 under prior regulations, but deregulation expanded this figure, reworking the ratio to a 3 to 1 gap. As the Wall Street Journal details:

According to the Maine Bureau of Insurance, a married couple age 40 to 44 with one child will pay $1,919 a month for a policy with a $2,250 deductible in 2013 if they choose to re-up their current policy. If the same family switches to the new health plan, or buys the plan for the first time, their premium will fall to $920, a 52% decrease. A couple over 60 could buy the same policy for $1,290, down from $2,466 under the old system. Or a young adult 25 to 29 could buy a high $10,000 deductible plan for catastrophic expenses for $232, previously $665.[21]

The 52% decline in premium costs is an extreme example, but the article explained that most showed declines in the range of 10-20%, while some older customers did have increases in costs.[22]

Hospital Restrictions

In 1964, New York became the first state to pass a “Certificate of Need,” or CON law. If someone were to propose building a new hospital, the state’s government would determine whether or not there was sufficient need. Then President Richard Nixon passed CON laws nationwide in 1972, believing that reducing the supply of hospitals would reduce health care costs. As basic economics tells us, limiting supply has the exact opposite effect on cost.

Since 1972, 14 states have repealed their CON laws, and for good reason. Numerous studies over the years have shown that CON laws have done nothing to reduce costs. In 1988, the Bureau of Economics Federal Trade Commission found that relaxing CON laws would cause total hospital expenditures to decline by 1.4%.[23] A 1991 study of 1,957 hospitals found that costs were higher in CON states.[24] Other miscellaneous studies show that CON laws have little or no effect on increasing costs, but do nothing to contain them.[25] Since we do not live in a world with too many hospitals and not enough patients, full repeal of CON laws would be a step in the right direction.

Malpractice Reform

Like CON laws, medical malpractice insurance accounts for a tiny sliver of our current health care costs. The CBO estimated in 2004 that malpractice insurance premiums totaled only 2% of all health care costs.[26] The way malpractice insurance increases costs comes from the expense itself as well as doctors performing “defensive medicine” when they perform additional unnecessary procedures “just in case” to avoid getting sued. While malpractice reform isn’t necessary for the sake of keeping costs down, it can help prevent states from losing doctors.

On the other hand, one estimate shows that around 10% of the money you pay to a doctor goes towards their malpractice insurance just in case you decide to sue them.[27] In 2003, Texas has placed a cap on the amount that can be rewarded from a medical malpractice lawsuit in order to solve these problems. Caps were placed limiting the amount one could be rewarded from a lawsuit to $250,000 ($750,000 in rare cases) for pain and suffering (known as non-economic damages), and up to $1.6 million in cases of death.

Many other states have limits on medical malpractice awards, but Texas’ limits are more than twice as strict as those of other states. Indiana, Nebraska, and Virginia for instance have their non-economic damages in the millions.[28] Doctors in Texas have seen their malpractice premiums fall over 20% as a result of the cap.[29] This has been appealing to both aspiring doctors and current doctors in other states. The Texas Medical board licensed 10,878 new physicians during the 2003-2007 period, an increase from 8,391 in the four years prior,[30] while over 7000 doctors migrated to Texas.[31] Doctors cited their reasons for migrating as lower insurance premiums, faster profit growth due to lower regulations, and various other perks such as Texas not having an income tax and low costs of living.[32] The costs of medical malpractice aren’t an uncommon motive for doctor migration – as Pennsylvania lost one third of its surgeons from 1995 to 2002.[33]

[1] Stossel, John. “John Stossel: Health Insurance Isn’t All It’s Cracked Up to Be.” AbcNews, 16 Oct. 2006. <http://abcnews.go.com/Health/PrescriptionForChange/story?id=2574980&page=1>.

[2] Cannon, Michael F., and Michael Tanner. “Healthy Competition: What’s Holding Back Health Care and How to Free It.” (Washington, D.C.: Cato Institute, 2005), p. 60.

[3] Pell, M.B. “Huge Hospital Markups Burden Patients.” Hospital Bill Review, 20 Apr. 2011. <http://www.hospitalbillreview.com/blog.php?post=14>.

[4] Morad, Renee. “20 Products With Giant Markups.” Yahoo! Finance, 27 Sept. 2012. <http://finance.yahoo.com/news/20-products-giant-markups-115730856.html>.

[5] Friedman, Milton. “How to Cure Health Care.” Hoover Institution, 2001. <http://www.hoover.org/publications/hoover-digest/article/7298>.

[6] Ibid.

[7] Friedman, Milton, and Rose D. Friedman. “Free to Choose: A Personal Statement.” (San Diego: Harcourt Brace Jovanovich, 1990), p. 205.

[8] The government has attempted to get around this problem by passing the Rare Diseases Act in 2002, which would offer financial incentives for companies to produce drugs treating or curing diseases that less than 200,000 people have.

[9] Ward, Victoria, and Nick Collins. “EU Bans Claim That Water Can Prevent Dehydration.” The Telegraph, 18 Nov. 2011. <http://www.telegraph.co.uk/news/worldnews/europe/eu/8897662/EU-bans-claim-that-water-can-prevent-dehydration.html>.

[10] Traister, Jeffrey. “Prescription Drug Cost Vs. Sale Price.” Livestrong, 27 Sept. 2010. <http://www.livestrong.com/article/260599-prescription-drug-cost-vs-sale-price/>.

[11] Davis, Sharon, and Mary Palmer. “Material Costs of Medical Compounds Investigative Research Reveals the True Costs of Drugs.” Rense. <http://rense.com/general54/preco.htm>.

[12] Forbes, Steve, and Elizabeth Ames. “How Capitalism Will Save Us, Why Free People And Free Markets Are The Best Answer In Today’s Economy.” (New York: Crown Business, 2011), p. 227.

[13] Seiler, John. “Mandated Health-Care Socialism.” The Freeman, Sept. 2007. <http://www.thefreemanonline.org/featured/mandated-health-care-socialism/>.

[14] Bunch, Victoria C. “Health Insurance Mandates in the States 2010.” Council for Affordable Health Insurance, 2010. <http://www.cahi.org/cahi_contents/resources/pdf/MandatesintheStates2010.pdf>.

[15] Seiler, “Mandated Health Care Socialism.”

[16] Ibid.

[17] Ibid.

[18] Schriver, Melinda L., and Grace-Marie Arnett. “Uninsured Rates Rise Dramatically in States With Strictest Health Insurance Regulations.” The Heritage Foundation, 11 Aug. 1998. <http://www.galen.org/fileuploads/THF_Uninsured.pdf>.

[19] Ibid., p. 264.

[20] Roy, Avik. “Putting the ‘Insurance’ Back in Health Insurance.” Forbes, 21 May 2012. <http://www.forbes.com/sites/aroy/2012/05/21/putting-the-insurance-back-in-health-insurance/>.

[21] “ObamaCare in Reverse.” The Wall Street Journal, 30 May 2012. <http://online.wsj.com/article/SB10001424052702304707604577426162012576398.html>.

[22] Ibid.

[23] Sherman, Daniel. “The Effect of State Certificate-of-Need Laws on Hospital Costs: An Economic Policy Analysis.” Staff Bureau of Economics Federal Trade Commission, Jan. 1988. <http://www.ftc.gov/be/econrpt/232120.pdf>.

[24] Bosse, Grant D. “Do Certificate of Need Laws Reduce Costs or Hurt Patients?” The Josiah Bartlett Center for Public Policy, Feb. 2012. <http://www.scribd.com/doc/81538887/Irrational-Do-Certificate-of-Need-Laws-reduce-costs-or-hurt-patients>.

[25] Ibid.

[26] “Limiting Tort Liability for Medical Malpractice.” Congressional Budget Office, 8 Jan. 2004. <http://www.cbo.gov/ftpdocs/49xx/doc4968/01-08-MedicalMalpractice.pdf>.

[27] Furchtgott-Roth, Diana. “Reduce the High Cost of Medical Malpractice.” Reuters, 6 Aug. 2009. <http://blogs.reuters.com/great-debate/2009/08/06/reduce-the-high-cost-of-medical-malpractice/>.

[28] Hyman, David. “Damage Caps and Medical Malpractice Litigation.” The Volokh Conspiracy, 2 Dec. 2008. <http://volokh.com/posts/1228240927.shtml>.

[29] Goldstein, Jacob. “After Texas Caps Malpractice, Docs Move In.” The Wall Street Journal, 5 Oct. 2007. <http://blogs.wsj.com/health/2007/10/05/after-texas-caps-malpractice-docs-move-in/>.

[30] Blumenthal, Ralph. “More Doctors in Texas After Malpractice Caps.” The New York Times, 5 Oct. 2007. <http://www.nytimes.com/2007/10/05/us/05doctors.html?pagewanted=all>.

[31] Furchgott-Roth. “Reduce the High Cost of Medical Malpractice.”

[32] Donnelly, Jon. “Malpractice Curbs Hailed, Faulted.” The Boston Globe, 26 Nov. 2007. <http://www.boston.com/news/nation/articles/2007/11/26/malpractice_curbs_hailed_faulted/>.

[33] Sowell, “Applied Economics,” p. 69.